1. UNIVERSITY EXTENDED LEARNING
Financial Accounting and Financial Management
2016

2. The Role of Accounting in Business
‘By inspection of a merchant’s books, by a man that hath skill, one may soon find out his wisdom and success, as well as his real worth.’
(North, 1714)

3. Decision making and information
Accounting is concerned with the preparation and presentation of : FINANCIAL INFORMATION Needed to make ECONOMIC DECISIONS

4. DECISIONS!!!

5. A CHOICE BETWEEN TWO OR MORE ALTERNATIVES
Can be RATIONAL only when sufficient information is available
Every individual or group in society makes decisions about the future

6. MANAGEMENT DECIDES HOW TO FINANCE OPERATIONS OF AN ENTERPRISE
To borrow funds from a lender?
Obtain funds from the owners, investors, shareholders?

7. CASH FLOWS!!!!!!!
A BUSINESS ENTERPRISE WITH CASH AVAILABLE WILL DECIDE ON THE TYPE OF INVESTMENT THEY WISH TO MAKE!!!

8. FINANCIAL ACCOUNTING CONTRIBUTES TO THESE DECISIONS BY IDENTIFYING:
What information will assist the various decision-makers;
How it should be measured; and
How it should be communicated to them

9. Users of Financial Information
Accounting provides information about various types of entities to a wide range of users, for the purpose of decision-making
It is often described as the language of business
Users of financial information maybe broadly categorised as primary and as other users

10. PRIMARY and Other Users
Are users who lack the ability to prescribe all the financial information they need from an entity
They therefore rely on the information provided in financial reports
Interested in assessing the entity’s ability to generate cash inflows, and
Managements ability to protect and enhance their investments

11. Accounting thought and practice
Can be classified according to the user group to whom it is directed!!!

12. DIFFERENCE
Financial Accounting is concerned with providing useful information about the business entity to the primary and other users (management)
Management Accounting is concerned with providing useful information related to the deployment of resources and exploitation of opportunities for management

13. The Accounting Information System
Selects data, processes that data, and produces information about an economic entity
The data that is selected has an economic impact upon the reporting entity
The input, processing and output of the system is governed by accounting principles, theory and concepts

14. Objective of financial statements
Provide information about the :
Financial position
Financial performance, and
Changes in the financial position of an entity that is useful to a wide range of users in making economic decisions

15. ECONOMIC DECISIONS Require an evaluation of the:
ABILITY of an entity to generate a cash flow
TIMING of that cash flow
CERTAINTY of that cash flow

16. USERS and their information needs
Capital providers
Equity investors
Lenders
Other creditors
Suppliers
Customers
Employees
Government and their agencies
Members of the public (stakeholders)
Primary Users
Other Users

17. Qualitative Characteristics of financial statements
Are attributes that make the information provided in financial statements useful
CONSIDER:
Threshold quality of materiality
The constraints of timeliness and cost/benefit

18. Qualitative characteristics
Fundamental characteristics
Relevance
Faithful representation
(complete, neutral, free from error)
Comparability
Verifiability
Timeliness
Understand-ability
Enhancing characteristics

19. Qualitative characteristics of useful financial information
Capable of making a difference in decisions made
Relevance
Materiality: Omitting influence decisions
Entity specific
Nature/magnitude
Predictive
/confirmatory value

20. Qualitative characteristics of useful financial information
Compare with other entities/
trends
Comparability
Identify similarities and differences

21. Qualitative characteristics of useful financial information
Knowledgeable/ independent observers reach consensus
Verifiability
Direct or indirect verification

22. Qualitative characteristics of useful financial information
Having information in time to influence decisions
Timeliness

23. Qualitative characteristics of useful financial information
Classifying, characterising and presenting information clearly
Understand-ability
Users have reasonable knowledge
Cannot leave out complex material information

24. GAAP What is GAAP? - Generally Accepted Accounting Practice
- set of principles
- IAS and IFRS statements
Helps all financial statements to be drawn in a similar manner
Includes a “Conceptual Framework”

25. CONCEPTUAL FRAMEWORK
General explanation of financial statement preparation
Basis from which all statements / standards are prepared

26. OBJECTIVES of financial reporting
To assess future net cash inflows
- Resources of the entity
- Claims against the entity
- How efficiently resources are used
Decisions depend on returns
- Equity (dividend and market price)
- Debt (interest, principal repayment)

27. Underlying Assumption GOING CONCERN
Financial statements are prepared under assumption that the entity is a going concern
Will continue to operate in forseeable future
No intention/need to liquidate
Why would they not be able to continue?
What other assumptions/basis can be used when preparing financial statements
How does this differ from Going concern assumption??

28. ACCRUAL BASIS When are effect of events recognised by the business?
- in the period in which an event occurs
- Income is recognised when it is EARNED
- Expenses are recognised when they are
INCURRED
Has NO link to when cash is received or paid
All financial statements are prepared on the accrual basis except for the cash flow statement

29. Internal Control
Ensures that a business organisation is effectively and efficiently run;
That the assets are safeguarded; and
That the financial statements faithfully present the information which they purport to present

30. A system of Internal Control ensures that:
The information that directors need to make decisions is available
The delegated authorities are properly exercised
The data needed for the control of costs is accurate and complete
The data needed for the preparation of financial statements is accurate and complete

31. Forecasting cash flows
External users need to predict the entity’s future performance and more specifically future cash flows
If a business does not generate enough cash, it may be unable to distribute cash to its owners, pay interest on borrowings, pay suppliers, repay loans
Cash flow is paramount in valuing a business

32. Cash Basis of Accounting
Measures performance by subtracting cash inflows from cash outflows to arrive at a net cash flow for the period
Operating activities
Investing activities Cash Flow Statement
Financing activities

33. The Entity Concept Entails identification of the business enterprise
Separation of the recording of transactions relating to :
- the business entity as an accounting entity
- the owners as the proprietor of the entity

34. Elements Assets - Resources Liabilities - Outside claim
Equity - Owners claim
Income
Expenses
Performance

35. Elements
Elements directly related to measurement of financial position
Assets, Liabilities, Equity
Elements directly related to measurement of performance
Income, expenses

36. Subsequent measurement
Timeline of elements
Element Definition
Initial recognition
Recognition Criteria
Initial measurement
Subsequent measurement
De-recognition

37. Assets: Definition Resource Owned/controlled by the business
Due to a past event
From with future economic benefits are expected

38. Assets: Recognition criteria
The inflow of benefits must be PROBABLE
The cost of the asset must be reliably measurable

39. Liabilities: Definition
Present obligation
Created as a result of a past event
From which future outflow of economic benefits is expected

40. Liabilities: Recognition criteria
The outflow of benefits must be PROBABLE
The amount of the liability must be reliably measurable

41. Equity = Assets – Liabilities
Equity is the difference between assets and liabilities
Residual claim
Equity = Assets – Liabilities

42. Equity Equity is also known as Net Asset Value (NAV)
This is what owners will be entitled to if the business closes (all liabilities will have been paid) – owners’ worth
How is equity (NAV, owners’ worth) affected by:
Income?
Expenses?

43. Cost Fair value of consideration or payment given for the asset Cash:
Paid on purchase date – cash given
Paid after purchase date?
Is R1.00 received today worth the same as R1.00 received in one year’s time?

44. Time value of money PV + interest 100 x 110/100 PV FV R110 R100
Assume an interest rate of 10% per annum
Over a year, you will earn interest
PV + interest
100 x 110/100 PV FV
R110
R100
One year
FV - interest
110 x 100/110

45. Cost
So....
The fair value of consideration or payment given for the asset when you pay cash after the purchase date is...
The Present Value of the amount paid in the future

46. Other measurement bases
Fair Value
The amount for which the asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
Present Value
Discount future cash payments for asset to today using applicable interest rate
Net Realisable value
What amount would we receive if we sold asset today less associated selling costs?
Current cost
What would the asset cost if we purchased it today?

47. Financing decision Where have the funds come from EQUITY DEBT
Funding from third parties:
Banks
Other lenders
Owner contributes funding to the business
- Capital
Business now has funding in the form of CASH or other ASSETS

48. Funding in the form of cash
Investing decision
Funding in the form of cash
SWAP
Assets purchased

49. Business uses assets to make profit (or loss)
Operating decision
ASSETS
PROFIT/LOSS
USE
Business uses assets to make profit (or loss)

50. Distribution decision
PROFIT
What the owner chooses to do with profit
Take profit out of business
Leave profit in the business
Retained profit
Dividend/drawings

51. Key business decisions
Financing decision
Where have the funds come from?
Owner (equity)
Borrow from third parties (liabilities)
Investing decision
What have we done with the funding?
Purchased assets for the business
Operating decision
Use assets to make profit
Distribution decision
What do we do with the profit?
Leave in or take out?

52. Where have the funds come from
BIG PICTURE
Where have the funds come from
EQUITY
DEBT
EQUALS
Assets purchased
USE
PROFIT
LEAVE IN
TAKE OUT

53. PROFIT = INCOME - EXPENSES
Profit and wealth
When a business makes a profit, the owner becomes wealthier
Objective of a business is to make a profit
Profit?
BUSINESS PROFIT
OWNER’S WEALTH
PROFIT = INCOME - EXPENSES

54. Financial reports
How will the business communicate the business’ information to users?
Financial reports – the basics
Statement of financial position
‘Photograph’ of the business at a specific date
Statement of comprehensive income
How the business performed over a period
Statement of cash flows
How the business used or generated cash over a period

55. Statement of financial position
Assets = Equity + Liabilities
What assets does the business own?
How have these been funded?
Equity – Judy’s Capital and leaving profit in the business
Liabilities – loans from the bank and third parties
Photograph of the business at a point in time
What assets and funding of those assets

56. Statement of financial position
A list of assets the business owns/ controls and how these assets have been funded - equity or liabilities.
The owner can fund the business
direct contribution - capital contribution
leaving profit in the business - accumulated profit/retained income

57. Statement of financial position
Intention of generating benefit from their use for more than a year
Assets
Non-current assets
 Furniture and equipment
950
 Cell phone
1 200
Current assets
 Inventory
3 600
 Bank balance
4 250
Total assets
10 000
Equity and liabilities
 Capital
8 000
Non-current liabilities
 Loan
2 000
Current liabilities
Total equity and liabilities
In the form of cash, converted into cash, or used within one year
Repayable over a period of more than one year
Repayable within one year

58. Statement of comprehensive income
Two components:
Profit and loss
Items that increase the wealth of the owner as a result of operating decisions (income and expenses)
Other comprehensive income
Increases in net asset value NOT directly related to operating decisions (i.e. revaluation surplus – see PPE)

59. Statement of comprehensive income
Rent received
Interest received
SALES/TURNOVER
LESS COST OF SALES
GROSS PROFIT
ADD OTHER INCOME
LESS OPERATING EXPENSES
PROFIT BEFORE INTEREST
Finance costs (interest expense)
PROFIT FOR THE YEAR
OTHER COMPREHENSIVE INCOME
Surplus on revaluation on land
TOTAL COMPREHENSIVE INCOME
Rent expense
Electricity
Wages and salaries
Depreciation
If 2 statements – this is were the I/S ends and SOCI starts

60. Statement of comprehensive income
The statement that shows all of these increases in NAV is the statement of comprehensive income
One statement versus two statements
The information can be shown as a single statement OR split into two statements: Profit and loss AND Other comprehensive income

61. Cash flow statement
SOFP – ‘photograph’ of the business on a particular date
SOCI – performance of the business over a period
Statement of cash flows – shows the cash inflows and outflows of the business
Only statement NOT prepared on the accrual basis

62. Cash flow statement Provides an analysis of the business’ bank account
Cash received (inflows)
Cash from customers (sales)
Cash from the owner (capital)
Cash from lenders (liabilities)
Cash paid (outflows)
Buying assets i.e. inventory or vehicles
Paying for expenses
Repaying loans
Drawings/distributions

63. Cash flow statement
What is the difference between the accrual basis and the cash basis of accounting?
Accrual basis – recognise incomes when earned and expenses when incurred (regardless of when the cash is received or paid )
Cash basis – amounts are only shown in the cash flow statements when the cash is ACTUALLY received or paid (regardless of when earned or incurred)

64. So is profit = cash in the bank??
Cash Sales
Expenses paid for, regardless of used or not
Cash paid to purchase assets
Cash to/from owner
Cash to/from lenders
Profit
Cash and credit sales
Expenses incurred